What You Need to Know About Reverse Factoring for Businesses
Ezra Cabrera | February 11, 2019
Many small businesses and startup companies experience issues with debt and cash flow. Poor cash flow can be an indication of early business failure which can effect your relationship with suppliers – especially if you owe them money. Business owners may resort to applying for a traditional loan, factoring or forfaiting, even liquidating assets or inventory in order to pay outstanding invoices. Fortunately, there’s an easier remedy to cash flow problems: What is reverse factoring?
Related: Invoice Factoring 101: Everything You Need to Know About Small Business Factoring
What is Reverse Factoring?
Many people are familiar with invoice factoring, but not everyone knows about its counterpart. As the name suggests, what is reverse factoring? (opposite of invoice factoring). Whereas invoice factoring is beneficial to businesses that are owed money from clients, reverse factoring benefits businesses that owe money.
If you’ve ever received an invoice, the first thing you notice is the payment due date – it’s typically 30, 60, or 90 days from the date of invoice. You never aim to make a late payment but there’s always a risk of simply forgetting to pay or having a cash flow shortage. This prevents you from meeting the agreed deadline. Fortunately, reverse factoring is a viable way to avoid this.
In reverse factoring, business owners inform their bank or lender to contact their supplier and ask if they are interested in ‘discounting’ the payment. This way, your suppliers are guaranteed to receive the payment before the due date in exchange for a small fee.
What are the Benefits of Reverse Factoring ?
It’s an ideal solution for businesses looking to gain a reputation for being reliable. Taking on reverse factoring guarantees that you’ll avoid late payments (and the penalty that comes with them) so you can prove to vendors that you’re a customer they can count on. Vendors love it when you pay early and it may also encourage them to offer you discounts, promos, or more favorable repayment terms.
Here are the other benefits of reverse factoring for both buyers and suppliers:
1. Improved Cash Flow
One of the most emphasized benefits of reverse factoring for suppliers is the availability of cash. Since the factors pay them earlier in behalf of the business that bought from them, they get to get the funds that was tied up in their unpaid invoices. This, in turn, improves their cash flow and strengthens their enterprise’s financial health.
2. No Need to Deal With Early Payment Requests
Although it’s understandable that most of your suppliers will send payment reminders, with reverse factoring, you won’t worry about missing these reminders. The factoring company will pay your invoice on your behalf. Your suppliers, in turn, won’t have to bother sending a payment reminder. The factors will settle your account with your suppliers according to the terms both parties have agreed on.
3. Maintains Buyer-Supplier Relationship
With reverse factoring buyer-suppliers disputes are avoided. The invoices are good as paid for when businesses gets approved for reverse factoring. And with that, since businesses can settle their accounts earlier on time, they preserve their relationship with vendors. Vendors, in turn, avoids losing loyal customers because of payment disputes. It’s a win-win solution for both parties involved.
4. Improved Credibility
Reverse factoring is also a great way to further improve your credit background. As all business owners know, credibility plays an important role in business transactions and loan applications. When you apply for reverse factoring, you’ll be able to pay your supplier dues on time. Aside from that, since the factor will collect the payments from your company’s customers. They will then deduct the loan you obtained from your customer’s payments. With that, you won’t have to worry about missing payments to your factors.
On time payments reflects positively on your credit report. Keeping up with your payments will increase your credit score and improves your chances of business loan approvals in the future.
What are the Disadvantages of Reverse Factoring?
The irony of reverse factoring is that it cannot be reversed. Once your supplier has agreed to your terms and payment orders have been set up, you are not able to cancel it. No matter what happens, you still have to pay your lender on or prior to the due date.
Factoring and Forfaiting for Businesses
If you want your business to grow and expand, factoring and forfaiting is always a good way to go. Almost all types of businesses benefits from reverse factoring. Reverse factoring has become more popular these days because of its flexibility. Reverse factoring works for all types of firms across various industries. However, it’s usually used by bigger and more established enterprises.
When you’re experiencing a cash crunch, there’s only one way to go: factoring and forfaiting. By seeking help through a third party, you can avoid all sorts of issues that might come between you and your supplier. Reverse factoring essentially preserves your relationship with suppliers.